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Chemicals Will Keep Bubbling

January 13, 1991

Industry Outlook 1991: MANUFACTURING

CHEMICALS WILL KEEP BUBBLING

Chemical executives have a ready answer when asked about their industry's prospects in 1991. "Just tell me what GNP growth will be, and I'll tell you how sales will do this year," says one company's executive vice-president. In the early 1980s, sales tended to rise twice as fast as gross national product. Since then, the chemical industry has matured: In recent years, growth has been running about 1.3 times that of the U. S. economy.

Most chemical manufacturers will be happy to get such an increase in 1991. Last year was tougher than expected: Overcapacity hindered profits of some basic chemicals. Dry weather in much of the U. S. farm belt and in Europe hurt agricultural pesticide sales. And Iraq's invasion of Kuwait caused unexpected increases in operating costs. Chemical companies use crude oil both as a fuel and a feedstock. So when crude prices doubled to $36 a barrel, that part of their operating costs shot up 50%, to $10 billion. The industry's shipments, at about $263 billion, were marginally higher than 1989's $256 billion. But aftertax profits dropped to about $20.5 billion, vs. $24.8 billion the year before.

RAINY SPRING? Crude prices should recede this year, however, assuming there's no lengthy Mideast war, and costs should go back down. Moreover, there will be fewer capacity additions to swamp chemical markets and undercut prices. And fairly normal rainfall is expected for the spring growing season. Thus, notwithstanding a softening in the U. S. economy, chemical companies expect a 5.3% increase in shipments, to about $277 billion. And they may even get a 5% increase in aftertax profits, to an estimated $21.5 billion.

Not everyone will hit those averages, of course. A November survey of the Chemical Manufacturers Assn.'s 182 members found the most optimism among companies with annual sales of less than $1 billion. Most of these don't make basic organic chemicals--such as ethylene--whose production cost is tied most closely to the price of oil. Instead, they buy basic organics from others and upgrade them into intermediate- or specialty-chemical products. In this business, it's easier to build in added value and pass on raw-material costs--and higher margins--to customers.

Still, costs are a major concern this year. Hourly wage rates will rise slowly, perhaps by only 4.5%, predicts Allen J. Lenz, the CMA's chief economist. But health care costs could soar by 12.7% in 1991. Another big item will be higher spending for new pollution controls mandated by last year's Clean Air Act. Pollution-abatement costs, which totaled $3.4 billion in 1989, could hit $6 billion by 1995, predicts Lenz. By 2005, the tab could increase to $10.4 billion, excluding expenditures for acid-rain prevention.

Small companies will be hit hardest. That's because they've done less cleanup than larger, more visible producers. Monsanto, the No. 3 U. S. producer behind Du Pont and Dow Chemical, is "far ahead of the Clean Air Act of 1990," says its chief economist A. Nicholas Filippello. "Our pollution-control costs," about $280 million a year, "are already built into Monsanto's capital base."

By contrast, the CMA figures that, at companies with revenues of less than $1 billion, pollution-control operating costs will rise an average 14.2%. Healthy prices could offset some of these increases. In 1990, the producer price index for all chemicals reached 120.5, using 1984 as the base year. This compared with about 113.5 for all U. S. manufacturing. Moreover, chemical inventories are relatively lean right now. Last year, the industry's inventory-to-sales ratio averaged 1.32, down from 1.36 a year earlier. And demand for most chemicals was reasonably steady toward the end of 1990, partly because of strong overseas orders. So unless the recession worsens quickly in the first half of 1991, the industry's capacity-utilization rate should hold at around 81%.

STEADY R&D. What is most encouraging to analysts, however, is that, despite the recession, U. S. chemical companies' investment in research and development isn't faltering. Last year, the industry spent $12.7 billion on R&D, according to the National Science Foundation. This year, that could climb to $13 billion.

Chemical companies also continue to compete aggressively in world markets. It's true that exports of basic organic and inorganic chemicals fell 35% last year, to $3.2 billion. But that was because big blocks of new production capacity came on stream in the Pacific Rim countries in late 1989 and 1990. For other products, including agricultural chemicals and high-performance plastics and resins, exports rose. Total chemical exports were $38 billion last year, up almost 5% from 1989, and the industry's trade surplus was $15.8 billion.

Foreign direct investment in U. S. chemical manufacturers is continuing to increase slowly. Roughly 25% of the industry is now foreign-owned. But no one is much concerned about that: "International direct investment in the U. S. chemical industry," says CMA's Lenz, "now supplies domestic producers with substantial net earnings." In 1988, the latest year for which figures are available, exports of U. S. parent companies to their foreign chemical affiliates and of U. S.-based affiliates to their foreign parents accounted for nearly 46% of all U. S. chemical exports, which totaled $32 billion that year.

Increasing dependence on exports can be a bit unsettling in a year in which the economies of many major U. S. trading partners are declining. But it says something important about the domestic chemical industry. More than other basic U. S. industries, it has learned to compete in international markets. This makes it resilient, and that, more than anything, bodes well for its future.Jane H. Cutaia in New York